Visa Inc (V), PowerShares QQQ Trust, Series 1 (ETF) (QQQ): Stop Putting Your Trust in These Popular Indicators

Other overbought and oversold indicators yield similar results. Testing shows that traders will not usually be profitable using indicators like RSI or stochastics with the standard settings to buy and sell.

The reason these indicators rarely work well is because in the long run, markets follow trends rather than behave like a rubber band. When they are trending, the size of the price moves tend to be large. During these trends, prices will remain overbought or oversold for extended periods of time.

There are times when overbought/oversold indicators will work. This will happen when prices are not trending. The price moves at these times will be rather small when compared to the changes seen during trends.

Overbought and oversold indicators should never be applied to market analysis. They are best used to identify short-term trading opportunities in a group of individual stocks. When using these indicators, experiment with different values such as a 2-day RSI or buying when the stochastics indicator falls below 5. If a large number of stocks are scanned for opportunities each day, there should be a number of trading candidates with this approach.

Only use indicators for their intended purposes. Overbought/oversold indicators are designed to spot short-term reversals and should only be used as short-term strategies. Because these indicators are for trading rather than analysis, use a well-defined exit strategy, like selling five days after buying. Rules like that implement the idea that prices act like rubber bands and use the indicators for trading rather than analysis.

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